Fixed Rate Capital Securities (FRCS) are hybrid securities that combine the features of both corporate bonds and preferred stock. FRCS may be structured as equity or debt; investors should read the prospectus carefully to determine whether a particular FRCS is equity or debt. FRCS carry the creditworthiness of the issuer, are fully taxable, and generally have a stated maturity. Some FRCS are perpetual, which means that there is no fixed maturity date. FRCS typically have higher yields than preferred stock and corporate bonds of the same issuer to compensate investors for increased risks. Investors should take the time to fully understand the features and risks associated with an investment in FRCS before investing.
FRCS typically offer a higher security claim than preferred and common stock, but rank junior and are subordinate in right of payment to all senior debt of the issuer.
Potential for attractive yields
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FRCS typically provide yield advantages relative to preferred stock and corporate bonds of the same issuer, partly to compensate investors for claims with a lower priority in addition to payment deferral risk.
Liquidity
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Certain FRCS trade on the OTC and listed markets, and generally have easily attainable quotes. Many FRCS are also listed on the NYSE®.
Credit ratings
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FRCS may be rated by investment rating agencies such as Moody's® and Standard & Poor's® to assist investors in their evaluations of the securities.
Low investment minimum
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Many FRCS are issued at $25 a share (although some are issued with a $1000 par value). This feature enables investors to buy and sell in smaller increments. The actual price paid by the investor may be more or less than $25, particularly when the security is purchased in the secondary market.
While it may seem appealing to look at securities that offer higher yields, investors should consider those higher yields to be a sign of potentially greater risk.
Market risk
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FRCS are subject to price fluctuation due to material events affecting the issuer or the market. Additionally, FRCS prices typically decline on ex-dividend days (the dates that buyers of FRCS are not entitled to receive the dividend).
Interest Rate Risk
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FRCS tend to rise in value when interest rates fall, and decline in value when interest rates rise.
Credit and Default Risk
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Investors should consider the possibility of risk that a corporation might default on its payments of interest or principal. Purchasing top–rated securities from companies with a stable or good credit history may help reduce credit risk.
Call risk
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FRCS generally have a call provision which entitles the issuer to redeem the shares prior to maturity. Typically an issuing corporation will call its securities when interest rates fall, leaving the investor with potentially less favorable reinvestment possibilities. When evaluating FRCS, an investor should know whether call options exist and when these options may be exercised by the issuer.
Special event risk
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Many FRCS include a "special event" redemption option, allowing the issuer to redeem the securities at the liquidation value if a tax law change disallows the deductibility of payments by the issuer's parent company, or subjects the issue to taxation separate from the parent company.
Deferral Risk
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FRCS permit the deferral of payments without declaring default, if the issuer experiences financial difficulties. Payments may be deferred or suspended for some stipulated period. If the issuer defers payments on a cumulative FRCS issue, the deferred income typically continues to accrue for tax purposes, even though the investor does not receive cash payments. Investors should consult with a tax professional regarding the tax treatment of investment income.
Inflation Risk
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FRCS are subject to the risk that the rate of the yield to call or maturity of the investment may not provide a positive return over the rate of inflation for the period of the investment.
The current market includes three broad categories or structures of FRCS which differ primarily as a result of whether the parent company issues the securities directly or through a conduit financing vehicle.
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Junior subordinated debentures are issued directly by the parent company
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Trust preferred securities are issued by a grantor trust established by the parent company
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Partnership preferred securities are issued by a limited partnership or limited liability company organized by the parent company
FRCS may also be described or identified by the following acronyms and names depending on the investment bank that serves as the issuer’s underwriter, the frequency of payments or how they are issued:
